Analysis: U.S. data, earnings suggest "fiscal cliff" fears overhyped

By Steven C. Johnson

Published February 06, 2013

Reuters

NEW YORK – Jon Najarian's no wimp. He's taken his shots more than once during three decades playing the U.S. stock and options markets and before that as a college football player. So he doesn't scare easily.

But when Congress seemed hell-bent on running the economy over the much-ballyhooed "fiscal cliff" at the end of last year, Najarian finally got skittish.

"For the first time in 31 years, I was completely out of the market at the end of the year," the co-founder of online brokerage TradeMonster.com said. "I thought Democrats and Republicans were willing to blow the whole thing up."

He wasn't alone. Scores of investors feared Congress would let some $600 billion in automatic tax increases and spending cuts slam the fragile U.S. economy just to make a political point and flooded the safety of money-market funds to avoid a potential plunge in stocks.

Business leaders at some of the nation's largest companies warned that tax policy confusion would suppress hiring, corporate investment and consumer spending.

And then, all of the fear disappeared into the wind. A deal struck on New Year's Day avoided most of the threatened tax hikes, which many feared would have plunged the U.S. economy into recession. The stock market soared to five-year highs. Business and consumer confidence improved.

The economy could yet be slowed by across-the-board spending cuts set to take effect next month. But most of the fears that had chief executives shouting about the sky falling didn't come to fruition.

Not only did the "fiscal cliff" danger disappear but another threat - to head-bang the economy against a ceiling on government debt - was later taken off the table for some months. Even the danger of gridlock leading to a government shutdown has faded.

It raises the question of how so many leaders misjudged the impending "fiscal cliff," particularly now that subsequent economic data and earnings reports suggest CEOs were either overstating the concerns to pressure Washington or using the so-called cliff as an excuse for any signs of underperformance as results reporting season came round.

CEOS CLAMORING FOR HELP

Corporate CEOs were the most vocal in urging lawmakers to avoid the "fiscal cliff," warning that uncertainty was suppressing demand and would prompt them to invest less. Executives from Wells Fargo, F5 Networks, Aetna Inc and 3M Co all expressed these concerns.

But economic data and the actions of some businesses in recent months suggest the concern may have been overdone.

DuPont saw fourth-quarter profits eroded by weak demand for paint pigment and solar panels, and CEO Ellen Kullman said the high U.S. budget deficit and uncertainty over tax and regulatory policy were holding the U.S. economy back.

In an interview, she said lawmakers should make up their minds and added that the company was considering putting off spending in 2013. The company's results for the fourth quarter of 2012, released on January 22, did beat Wall Street expectations.

However, economic figures failed to bear out some of the warnings. U.S. orders for long-lasting manufactured goods came in at better-than-expected levels for the last three months of 2012, as consumers were continuing to spend.

Meanwhile, mergers-and-acquisition activity in the Americas picked up sharply in the fourth quarter, with about $427 billion in announced deals, compared with about $272 billion in the year-ago period, according to Thomson Reuters data, a sign of renewed confidence by businesses in spending their cash.

The fiscal cliff may have induced companies to tread cautiously, but it didn't stop them from spending altogether.

Bank of America Merrill Lynch said in a note to clients that company guidance on expected capital expenditures hit bottom in October, but has been trending upward since. In January, the ratio of companies raising expectations for such spending to those lowering hit 4-to-1, its highest in more than a year.

And as soon as a deal to avoid the cliff was struck, money started pouring into mutual funds and exchange traded funds. Investors added $34.2 billion to equity funds in the first four full weeks in January, according to Lipper data.

Kim Forrest, senior equity research analyst at Pitt Capital Group in Pittsburgh, said some of the most dire warnings on the fiscal cliff were probably intended to lower expectations.

"It's the job of a CEO to set the appropriate bar for expectations at any given time, and allowing analysts to have too rosy a view isn't going to serve their shareholders well in the short run," she said. "So I think all that negative talk really did reset expectations."

Kevin March, chief financial officer at computer chip maker Texas Instruments, partly blamed the "fiscal cliff" for making customers reluctant to make big orders. The company's revenue fell 13 percent in the fourth quarter compared with the same period a year earlier.

The company beat expectations in the fourth quarter, but warned of uncertain demand in the first three months of 2013.

Meanwhile, the Semiconductor Industry Association noted that chip sales in the Americas were up 13.4 percent in December from the previous year, and increased 12 percent quarter-over-quarter, though the SIA did say that policy uncertainty posed "risks to the near-term market outlook."

Of the 53 percent of S&P 500 companies that have reported fourth-quarter earnings, 69 percent have beaten profit expectations, according to Thomson Reuters data. That is a higher proportion than over the past four quarters and above average since 1994.

SPOOKING MARKETS

All the doom and gloom from corporate bosses and the round-the-clock coverage of the "fiscal cliff" in the financial and mainstream media, certainly spooked markets in December, and stocks ended an otherwise strong 2012 on the defensive.

Politicians did not inspire confidence either. Bickering between Democrats and Republicans brought back bad memories of 2011, when lawmakers toyed with letting the country default to force concessions on spending. It also recalled the failed congressional vote in 2008 to raise emergency capital for banks, which caused a panicked sell-off in stocks.

In fact, the market's near-death experience in 2008, when Lehman Brothers collapsed and the global financial system seized up, makes people more prone to see every new risk as an existential threat, said Dan Ariely, professor of behavioral economics at Duke University's Fuqua School of Business and author of "Predictably Irrational."

"I think that in the financial industry, we've been told and trained" to be fearful, he said.

Of course, not every CEO had the sky falling. Aetna's chief financial officer, Joe Zubretsky, said in December that "we're pretty much assuming the cliff gets solved."

In the end, that's what happened. Data last week showed employers added 127,000 more jobs than initially reported in November and December. Retail sales rose 0.5 percent in December, but some fear a hike in the payroll tax that took effect in January will cut into spending in the months ahead.

Earnings still face headwinds, but stocks kicked off 2013 with their longest winning streak in eight years. Both the S&P 500 and Dow hit five-year highs and rest a few percentage points from all-time records.

"Were we overly pessimistic? Of course, the answer is yes," Najarian said. "But I'm more than happy to have been wrong about this."

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